Incorporating a suitable risk management plan into your CFD trading trading plan is the single most important aspect of CFD trading. Risk management entails determining the amount of money that you want to allocate to every trade to ensure that you can carry on trading should you sustain a loss on the position.

Trading CFDs with no proper risk management plan can expose you to unnecessary risk. For instance, if you allocate a significant portion of your trading resources to a trade without a proper risk management strategy, you put all your trading capital in danger, meaning that if you sustain a loss you’ll no longer be in a position to trade. Losing your entire capital base can force you out of the market and you will not even have the chance to regain your losses.

The most typical type of risk management is position sizing, this is also called the fixed dollar trade size model. In this example an equal quantity of capital is used for each trade.

As an example, if you have $100,000 to invest, you will need to determine just how much to put into the trade. To work this out you’d simply divide $100,000 by the cost of the CFD. If the last traded price of the CFD was $8.50 you’d divide this by $100,000 to work out the total amount of CFDs you can buy. In this instance the number is 11,764.

In order to work out the total amount of risk involved in the trade you’ll have to determine how much you can afford to lose should the CFD move against you and place your stop-loss at this point. This is also referred to as the stop-loss distance, that is the distance between the entry and stop-loss price.

For instance, if your stop-loss price is $8.00 and entry price was $8.50, this means that your stop-loss distance will be $0.50. If you have 10,000 CFDs your risk will be 10,000 multiplied by $0.50 or $5,000. In this instance your risk will be $5000, which equates to the quantity that you are able to lose should the trade move against you and you get stopped out.

It is also important to factor in the rate of commission and any financing costs that you could have incurred from holding the position overnight.

In the fixed dollar trade size model the quantity of CFDs that you buy and sell each time will not always be the same, this is because the stop-loss size will vary depending on the risk appetite you have on the trade.

An additional form of risk management is compounding, which means as your trading account balance increases, you are able to open larger positions.

For example, if you have a starting balance of $100,000 and you have determined that you could afford to have 10 trades open at any given time, as your account balance grows, it is possible to take on bigger trades. This plan can be used up to a point when your draw down gets too big for your liking and risk appetite.

It’s also crucial that you note that if you’re trading a CFD which has liquidity issues, you may get to a position where your trade sizes are too great, as such you will have to take smaller positions.